The 4 Factors that Make a Great Stock

BlackRock strategist Holly Framsted explains the qualities that signal a stock can outperform over the long term.

This transcript has been automatically generated and may not be 100% accurate.

I ... investors have forever puzzled about what it is that makes stock a great investment here's the scientific approach to answering the question ... Jack Otter editor at Barron's Stock ... on your colleague friends that ... factor investing specialist at BlackRock ... up before we get into us for what you see in the market can you briefly explain what he is factor investing is a lot of buzz about right now ... sectors aren't the fundamental drivers of investment returns you can think of factors to stocks like you think of nutrients to fit ... so it just like milk and state have essential fats and proteins that they contribute your diet but they may look very different the surface ... so does every stock after a bunch of factors that contribute to their returns over time ... and so effectively you can break down in investment return into those factors which might be beneficial just like you can break down your predicted into those nutrients that might be beneficial euro crop and there are four factors that you talk to ... there are four main factors they tend to drive positive investment returns over time ... those are qualities ... value moment and and science sizes smaller capitalization and fasting ... now those four factors tend to drive outperformance over the market we would also add minimum Volatility into the mix if we're talking about the benefit of reducing risk in a portfolio swap appearances or is taken some good value investing approach ... aam and that's an interesting subject right now because value had a tough few years seems to be coming back to talk about that ... yes a value investing is a ballot buying companies that are priced inexpensively relative to their fundamentals ... and eight ... fundamentally this works because you are reporting or investors are being rewarded for risk that they're taking in the portfolio ... a typical value stocks often screened by metrics such as a price to book multiple or forgetful returnees to price enterprise value to cash flow ... as an example of metrics you might use tends to be very procyclical ... these types of companies tend to have very inflexible business models silky pink and General Motors that's actually largely in a single factor value fund to be LUV ... and that type of company has a lot of operating leverage as long as people are buying parts ... but the second that the economy starts to head toward the downturn and sweets growth declines as people start losing their jobs ... the last thing that they continue to buy is a brand new vehicle that might might be unnecessary ... now it seems the economy starts to pick back up again and people begin to replacing ... repeat in replacing cars ... in companies like General Motors will capture that uplift in the economy much more efficiently ... so this is operating leverage becomes beneficial in positive up prices in the market GM is interesting choice just because it does look so cheap and it has looks so cheap for so long now ... on any idea why that is and ... the things that are going pretty well actually car sales have been doing well but it's still cheap with what's going on ... yes sadly so any individual stock will have idiosyncratic risk associated with it and has been a lot of uncertainty but frankly in a in the economy despite the fact that the markets have been doing well ... what we've seen posts I've Trump election he is actually an uplifting performance and value stocks I think companies like General Motors will experience that uplift in the economy collectively ... another thing you mention this quality and that so is the favorite description of mind is nobody wants to say all I have all these lousy stocks their loan quality ... so how do you define quality and why does it with ... of course so quality is a more defensive after a tense to beat the market over time that it has a slightly lower beta assets can beat the market by a slightly lower magnitude ... then I type of investment like found your plant ... quality were typically looking at the strength and consistency of the balance sheet ... still metrics such as return on equity ... earnings consistency over time ... and low leverage ... we analyzed balance sheets and are able to screen for stocks based on those metrics he will get investments in companies like Johnson Johnson ... which have strong balance sheets and consistent earnings effort ... no ... steam engine smaller on that there's a famous academic study by Fama and French and that under the hold mutual fund firm called the FAA on the idea that smaller value stocks do better ... on say you're working off that that maybe the fuel for that yet so it's the same concept reality then factor investments that you were seen come to market today or that have been in market for the last few years are really based on a lot of the same ... academic evidence from entrench a seminal study in the nineteen nineties for value in small cap investing is currently are is actually the underpinning of freely all our strategies that yes ... it speaking to the concept that smaller companies in an investable universe tend to be larger companies over time ... they tend to come with higher risk so you are taking on more beater with that investment but if you have a lot of cooking period you should be able to overcome that risk through excess return to protect ... our one more factor on talk of a ... yes so the final factor is momentum ... and momentum is all about price trends so will we think about Momentum Investing were looking at how a company has been treating in the market specifically were looking at six and twelve month risk adjusted access returns ... because when one understands not only got a company is trending but how is trending over time ... a company like Amazon is a great example since the beginning of two thousand fifteen They've been trending strongly in the market ... and what we know is studies that come again out of the early nineteen nineties will propose that stocks that have been trending in the market ... will continue to wean for some time before they prefer ... it's all about hurting the heat here and so of momentum strategies try to capitalize on that note hurting heat here in investing in winners and I guess if you take other factors that work ... and the new look for the ones that have those factors that have momentum and then you start to get a winning strategy ... exactly so we would propose that you should combine multiple factors together in a portfolio ... as we talked about what value it can have really high returns over a long investment horizon but ... in five out of the last six years on a global basis value investments have underperformed the market so you need to have a sufficiently long investment horizon for any single factor to overcome the cyclicality in performance that you see ... if you combine factors like value and momentum for example which tend to do well at different times and for different reasons ... than they can be diversifying relative to one another animal tie factor approach can really help you smooth the ride while seeking outperformance in the market and the contrary in the things that are proven strategy that has lagged in five or six years sounds like it might be a good place to be ... absolutely thanks for much help things ...